Vinati Organics

Background

Vinati Organics Limited was promoted by first generation entrepreneur Vinod Saraf in 1989 to manufacture specialty organic chemicals. Vinati is a niche player but has already achieved global recognition and size.

With ATBS, Vinati has broken into the exclusive club of ATBS manufacturers. There are only three other manufacturers of ATBS globally viz. Lubrizol (USA) ~14000 TPA, Toagosei (Japan) ~8000 TPA and a Chinese company with small capacity of ~2000 TPA.


Main Products/Segments

  • Iso Butyl Benzene (IBB) – largest manufacturer – 14,000 TPA – 60% global market share
  • 2-Acrylamido 2-methylpropanesulfonic Acid (ATBS) – 2nd largest manufacturer – 12,000 TPA -25% global market share.

In FY 2010 IBB contributed 54% , ATBS contributed 44% while Others contribute 2% of the Sales mix. Contribution from ATBS has been steadily growing over the years and in 1Q FY 2011, ATBS has already overtaken IBB contributing ~57% to the Sales mix.


Main Markets/Customers

Domestic market for its products is small, the Company exports bulk of its products to USA, Europe, Australia, Middle East and China. Export contribution in FY 2010 is ~75%

  • IBB – is the primary raw material for the popular painkiller Ibuprofen – supplied directly to Ibuprofen manufacturers like BASF (largest Ibuprofen manufacturer), Shashun Chemicals, Biocause (China) the other large scale Ibuprofen Manufacturers.
  • ATBS, Na-ATBS and other derivatives that the Company makes are specialty monomers having wide applications mainly in acrylic fibre manufacturing, adhesives, and personal care products. These are supplied to polymer manufacturers who then sell the polymers to users through their distribution channels. Direct sales of ATBS are only to acrylic fiber industry.
  • New Applications like Enhanced Oil Recovery & Water Treatment hold substantial potential for growth of ATBS and global demand is expected to go up 2-3 fold (Source: company)
  • Some of the key clients are BASF, AkzoNobel, Ciba, Perrigo, Rohm & Haas, Clariant, NALCO, Shasun Chemicals

Bullish Viewpoints

  • Competitive edge in niche specialty chemicals – Cost leadership & scale economies in IBB and technological entry barrier in ATBS are strategic advantages. VOL is making its presence felt in specialty chemicals where there is less competition globally, technology is not easily available and large players are probably not interested due to relatively smaller global market size of the products.
  • Most impressive track record in last 5 years – The growth snapshot shows while Sales have grown at a compound annual growth rate (CAGR) of 41.78%, EBITDA has grown at an accelerated pace of 73% CAGR over the last 5 years. EPS (adjusted for stock splits) has galloped away at over 112% CAGR on expanding margins. The profitability analysis shows Operating Margins have gone up from 10% in FY 2006 to over 22% in FY 2010. Net Margins have done better going up from 3.4% in Fy 2006 to over 17% in FY 2010. RoEis over 40% and RoCE at ~34% in FY 2010 from single digit figures in FY 2006.
  • Ranked #14 among India’s top 100 fastest growing companies -Economic Times, Oct 2009
  • Focus on high-margin ATBS – The worldwide demand for ATBS is about 30,000 TPA and is growing at about 10-15% annually.  Vinati has seen its ATBS business growing at 40%  in FY10 and sees this trend continuing in FY11. Moreover, it is expected that the demand of ATBS could double over the next 2-3 years due to its application in enhanced recovery oil polymers. Plans are on to expand ATBS capacity to 18000 TPA from current 10000 TPA by December 2011. Margins from ATBS are around 25-30% while those for IBB are around 15-20%.
  • Backward Integration into Isobutylene – The company has completed a backward integration project of ATBS by manufacturing Isobutylene (IB) a key ingredient. The IB plant with a capacity of 12000 TPA has commenced production in June 2010. Hitherto IB was imported from Europe & Taiwan in pressurized tanks. The freight cost per kg of IB is about Rs. 20. One kg of ATBS requires about 0.35 kg of IB. In FY11, VOL’s demand for IB could be atleast 3,000-4000 MTPA. Thus, the cost savings based on freight and captive consumption of IB alone could be to the tune of Rs. 6-8 cr.
  • Replace Import demand of IB in domestic market – ~4000 TPA of IB would be used for captive consumption while the remaining would be sold off in the market. Currently, the only domestic manufacturer of IB is Savla Cemicals who has a capacity of 5,000 MTPA. The demand for IB in the domestic market (not including VOL’s demand) is about 10,000 MTPA. The demand supply mismatch is currently being met by imports.
  • New products to add to revenue stream –  Several new products in pipeline are also coming onstream in 2HFY11 which include ATBS capacity expansion, Tertiary Butyl Acrylamide (TBA), Tertiary Octyl Acrylamide (TOA), Di-Acetone Acrylamide (DAAM). The new capacities of TBA, TOA and DAAM could help the company to improve turnover significantly by FY12.
  • Proximity to Mumbai and JNPT port – greater ease of logistics and access to advanced infrastructure facilities.
  • Environment-friendly operations include waste product recycling. With the aim to be a zero-effluent company, VOL has focused on recycling and monetising waste byproducts of ATBS like TOA, TBA, and DAAM as mentioned above.

Bearish Viewpoints

  • Highly dependent on two products – Currently VOL derives its revenue from two products – namely IBB and ATBS. Thus the company is highly sensitive to any additional capacities, market changes etc. affecting either of these two products.
  • Muted growth for IBB – IBB is the primary raw material for Ibuprofen a mature product with expected growth of ~3-5% CAGR. Capacity expansion and newer capacities from players like IOL Chemicals & Pharmaceuticals limited (6000 TPA) has started impacting margins.
  • Lower than expected offtake of IB – VOL has a 12,000 TPA facility of IB. Requirement for captive use of IB in ATBS is 3000-4000 MT. This is expected to go upto 6000 MT when ATBS capacity reaches 18000 MT by FY11 end. The company has been unable to sell the balance in the domestic market. Savla Chemicals the other domestic manufacturer of IB is a competitor.
  • Aggressive Capex plans – As per FY 2010 Annual Report, VOL is carrying out capex of about Rs. 77 Cr in FY 2011. Also there is a 5MW co-generation plant (coal based) expected to be operational by end of FY11 involving a capex of around Rs. 33 Cr. While operational leverage takes time to kick in, there is a possibility of increased interest and depreciation costs, and lower capacity utilisations having a negative impact on bottomline. Execution risks remain significant as more aggressive plans have been announced and re-iterated in this August 2010 Analyst Meet.
  • Higher Tax payout from FY 2012 – ATBS manufacturing facility at Lote, Maharashtra enjoys 100% EOU tax exemption. Such tax breaks are available till March 2011. From FY12 onwards tax payout will see a big jump which will impact net margins significantly.
  • Volatility in crude oil prices – The main raw materials required for the manufacture of IBB and ATBS are crude oil derivatives such as toluene and propylene. Any major fluctuations in the prices of crude oil could adversely affect VOL’s performance (due to the 3 months time lag in passing on the increase in cost to its customers) especially for fixed price orders.
  • Foreign currency fluctuations – VOL exports ~75% of Sales. Thus, it is a net receiver of foreign exchange. It procures raw materials through imports and local purachases, where local purchases track import parity price.Thus raw materials and the FCNR loan it has taken provides a partial natural hedge. Unforeseen sharp fluctuation in the value of the Rupee could affect its realization and margins at least temporarily. Long Term contracts have provisions for shared currency risks.

Barriers to entry

  • ATBS technology is exclusively licensed from National Chemical Laboratories (NCL) Pune. The process developed by NCL is protected by two US patents (6,504,050 and 6,660,882). A third PCT application has been filed. Development of Process Technology for SMAS & ATBS
  • IBB technology is licensed from Institut Francais du Petrole (IFP) France. With 60% market share VOL enjoys cost leadership & scale economies in IBB
  • Its not easy to manufacture these products to exacting requirements of quality. It took Vinati 4 years to get the quality right on ATBS.
  • Since these are niche products with only a few large scale suppliers, major customers usually enter into long term contracts. BASF had entered into a 5yr contract for IBB (till FY 2011). ATBS contracts are of 1-3 years durations.

Interesting Viewpoints

  • The worldwide demand for ATBS is about 30,000 MTPA and is growing at about 10-15% p.a. Moreover, it is expected that the demand of ATBS could double over the next 2-3 years due to its application in enhanced recovery oil polymers. (Source: company, HDFC Securities)
  • Backward integration into IB may assist in VOL’s quest for leadership position in ATBS
  • The company is further de-risking its product profile by investing in a new product Para Amine Phenol (PAP). A key ingredient in manufacture of paracetamol, PAP is being produced in a pilot plant using a new NCL Pune developed technology, (single step catalytic hydrogenation of nitrobenzene) since there are issues of large amount of effluent generated and technological gaps in the existing conventional technology. The technology is meant to be environment friendly and competitive internationally with other technology
  • The company has already invested around Rs 4 crore on R&D and hopes to complete the pilot trials on PAP by October 2011 when more clarity would emerge. Once the pilot runs are successful, VOL could set up the plant which would take another 18 months to go onstream. If successful the prospects of VOL could further improve from here on.

Disclosure(s)

Donald Francis: No Holdings in the Company;


Astral Poly Technik Managament Q&A: May, 2011

Management Q&A

Astral Poly Technik Stock Story will leave you impressed. It has made some rapid strides in the last few years. It’s a leader in its niche CPVC Pipes & Fittings industry segment. It continues to grow robustly with compounded annual growth of over 50% in Sales over last 5 years!

With its excellent fundamentals, Astral Poly Technik made it easily to our shortlist of promising small-cap stocks – that our in-depth process for hand-picked stock-picks throws up.

There are a few questions that came up during our detailed analysis on Astral Poly Technik, its prospects, and risks as we see it. (of course that is entirely based on published sources and without the benefit of a meeting/interview with Management).

We put forward these questions to Astral’s Management with a request for a meeting/visit to its premises. We visited and talked with CFO Hiranand Savlani for over 2 hours, who patiently answered all that we posed.


1.     ASTRAL HAS HAD A BLAZING RUN OVER THE LAST DECADE. SALES AND PROFITS HAVE GROWN AT OVER 40% CAGR. APL WILL PROBABLY DO OVER 400 CR IN FY11. THAT’S A SUPER ACHIEVEMENT. CONGRATULATIONS!

What are the future plans? Where does the company see itself in the next few years? We have heard the company talking of maintaining a 30%+ growth rate and a 1000 Cr turnover goal – Kindly explain what it will take to achieve this and what are the important milestones in this journey?

The market is huge and there is enough space for more players. we see us growing at 30-35% CAGR for the next few years. If we execute well, a Rs. 1000 Cr turnover is achievable within the next 3 years. New innovative product introductions and maintaining the quality of our distribution network and strengthening it will be key factors.

We ask all our shareholders to be long-term investors, and stay invested for the next 5 years. It will be a rewarding journey for all of us stakeholders in the company.

2.     CPVC RESIN SEEMS AVAILABLE FROM MULTIPLE SOURCES; CPVC COMPOUND AVAILABLE FROM NOVEON USA & AKREMA, FRANCE. NOVEON PATENTS ARE SET TO BE EXPIRING/EXPIRED

Please demystify this market for us. What is really patent protected, and for how long? Apart from Noveon and Akrema are there other licensors of CPVC compound? Are people able to make CPVC pipes with CPVC resin and indigenous compound knowhow??

Patents have expired. But the availability of the compound is a key constraint. Apart from Lubrizol, there are some 3 other known manufacturers. Akrema of France, Kaneka and Sekisui of Japan.

There some 20 CPVC pipe manufacturers in India today. Most of the non-Lubrizol licensee capacities are at a nascent stage and in 100s of tonnes. The largest may be some 3000 tonnes. The availability of the CPVC compound (other than Lubrizol) is a key constraint. Many are experimenting with in-house compounds, but are not able to scale up majorly without a guaranteed RM source.

3.     GI PIPES & STEEL PIPES ARE STILL THE MAINSTAY OF PLUMBING AND FITTINGS MARKET IN INDIA. SOME STUDIES ESTIMATE GI PIPES CONTINUE TO HOLD OVER 50% MARKET SHARE, WHILE THE PVC/CPVC MARKET IS STILL SOMETHING LIKE 5% OF THE MARKET.

Kindly give us your estimate of the current Indian market for plumbing & fittings. How do you see CPVC/PVC market growing in the next 5 years? Is CPVC likely to replace PVC totally or both will continue to co-exist.

This is difficult to put an exact figure on. By all accounts this is a huge market. The GI market itself a Rs 7,000 Cr market as on today. SWR pipes (PVC based) is reportedly a Rs.3000 cr market today. One Mumbai distributor alone is doing a Rs 50 Cr business just from SWR. Then there is Underground drainage systems which is big. There is Blazemaster potential market of atleast 700 Cr. In all, the total market for pipes and fittings in India is by some accounts a Rs. 20,000 Cr market, today.

GI Pipes days are over. The organised construction players have already switched. End users are aware, depending on the location and corrosiveness/water properties the life varies form 7-10 to 12 years for GI. Whereas CPVC has no such problems.

The plumbing community is a big pusher towards CPVC. Their productivity has gone up as the handling/fitting is much easier (Just an adhesive glue, rather than threading and refitting and the like). If they could construct  one GI bathroom a day, they are able to finish 3 bathrooms today in the same time. They also find the product, fittings & installation hassleless and are the biggest promoters for CPVC pipes & fittings.

4.     EXPORT MARKET POTENTIAL. 30% IN KENYA JV. LUBRIZOL LICENSING POLICIES

Exports are a very small market for Astral today. Are there any ambitions to scale up this segment? Tell us more about the Kenya JV, Is there any strategic intent, and why Kenya? What is Lubrizol licensing policy for markets other than India? Do you have any leeway for south asian and middle-east markets or are they subject to separate licensing?

The Kenya market license is with Astral Poly Technik and we have extended it to the JV. It is Lubrizol which asked us to look at that market and we preferred to set it up jointly with another entity where the risks are spread. As you might have seen we have increased the stake, and have the rights/mechanism to increase the stake in proportion to market development.

We have a very big domestic market to take care of, first.

5.     OTHER NOVEON LICENSEES IN INDIA INCLUDE AJAY INDUSTRIAL CORP AND ASHIRVAD PIPES PVT LTD. ASHIRVAD PIPES HAS OVER 50,000 MT CAPACITY AND A 2008 RECIPIENT OFNATIONAL AWARD FOR OUTSTANDING ENTREPRENEURSHIP IN MEDIUM ENTERPRISES. AJAY INDUSTRIAL CORP HAS OUTSTANDING GROUP COMPANIES LIKE PRECISION PIPES (LARGEST SUPPLIER OF AUTOMOTIVE EXTRUDED PARTS) AND AJAY POLY (LARGEST SUPPLIER OF EXTRUDED REFRIGERATION SEALING SYSTEMS)

These are pedigree companies. How serious is the competition? Is it head-to-head in Flowguard Sales, or do you/they have an edge in some segments within Flowguard range. If you have any competitive advantage over these two, what would those be? Does your/competition distribution network play a significant role? Are there any regional markets that you/competition dominate?

These are also big players in this market and there is room for all to grow. Both are unlisted players and we are not aware of much details on their dedicated CPVC capacities. We have strong presence in West and South markets and now turning the focus to North and East.

6.     CPVC LICENSING AND MANUFACTURING.

Kindly explain the role that Lubrizol & Specialty process LLC plays. What is the kind of relationship that you enjoy with them, and are you deriving any competitive advantage from the strength of these relationships today? Why aren’t say established PVC/GI players moving fast in CPVC? What prevents them from approaching Lubrizol with bigger plans than yours? What about manufacturers setting up plants in say Nepal and target Indian markets?

Lubrizol has policies that are licensee-friendly and protects the licensees that take the initial market risk with them. In a market like US, they have appointed only 4 licensees over the last 42 years. That speaks a lot for their policies.

When we take initial market risk for a product and are the first licensee, usually we are assured of a 5yr exclusivity. I am not just taking the license, I am spending money and effort in UL certifications (where they stress the product in test conditions for over 18 months) and other market development activities. Lubrizol has an equal stake in making us succeed -those who take the early risk.

Q: So, did you get an exclusivity on Flowguard license?

Yes, The others have the license only since the last 6 years. We have had that for the last 11 years.

For the Indian market Lubrizol had first approached the established bigger players like Supreme and Finolex in 1998-99. However when they did not take up on that offer, an unknown entity like Astral Poly Technik came forward and took on that initial market risk.

Like for any other market, Lubrizol understands the peculiarities of the Indian market. We have taken the early risks and have developed the market from scratch and we have had their constant support. We have a strong relationship. It is unlikely to jeopardise a relationship that goes back so many years, especially when we are giving them high growth. Peculiarities of the sub-continent are not unknown to them! Anyone getting a license for manufacturing in Nepal or other such places is probably remote.

7.     BLAZEMASTER FIRE SPRINKLER SYSTEM – YOU HAVE THE LUBRIZOL LICENSE SINCE 2008. DESPITE HAVING THE NSF & UL CERTIFICATION, LOCAL BIS CERTIFICATION IS YET TO BE RECEIVED, FOR WHICH APL HAS BEEN DOING THE GROUNDWORK FOR LAST 2 YEARS.

Kindly explain the importance of Blazemaster to product plans and future growth of the company. Realistically when do you see a pan-India launch? While this will give you an edge over other Noveon licensed CPVC manufacturers, how long do you expect to sustain this first-mover advantage? All your groundwork in getting local approvals actually works to the advantage of the guy moving in next after you! Lubrizol must be aware of the situation – what kind of guarantees do you have from them for protecting you on this front for the Indian market.

Blazemaster Fire Sprinkler system has very big potential and it has ready acceptance from the corporate segment. We are hopeful of an early launch. There is a review slotted in May/June by the standardisation body. It may or may not come through this time. But we are almost there, all the groundwork is done.

Blazemaster should also enjoy a 5yr exclusivity.

8.     NEW PRODUCTS SWR PIPES, UNDERGROUND DRAINAGE PIPES, FOAM CORE PIPES, MANHOLES AND INSPECTION CHAMBERS.

Kindly explain the process of new product introductions in the Indian market. Do you require to take specific BIS/ISI approvals for each of these products. What is the status on pan India launch for all these products? Currently what is the revenue contribution from new products?

Blazemaster is the only product for which BIS approval is required as Fire Sprinkler is a category that needs to go through the standardisation process. None of the other products require such approvals.

Pan India launch and availability is a long slow process. It usually takes from 3-4 years. Most of the new products are finding good acceptance and growing very strongly. SWR Pipes is doing very well. It will be some time though, before we have significant revenue contributions from new products.

9.     PRODUCT SEGMENTS, GEOGRAPHICAL SEGMENTS, REPLACEMENT MARKETS

Kindly give us an idea of the revenue contribution & margins from major product segments, also rural and urban markets, and replacement market. Which segments are expected to drive growth in next 2-3 years, where is the company’s focus and why? How much do the brands Flowguard and Corzan contribute today to revenues and going forward what’s the scenario? How big is the lead free PVC segment?

CPVC Pipes & fittings contribute 65% of the Sales mix. PVC products bring up the balance 35%. Pipes contribute 55-60%, while fittings contribute 35-40%, rest is from others. Traded goods constitute roughly 10% of Sales -mostly Solvent Adhesives and some fittings where the volumes do not justify manufacturing. We are manufacturing some 700 varieties of fittings ourselves, today.

10. CUSTOMER SEGMENTS –TOP CUSTOMERS & REPEAT BUSINESS

What is the revenue split between residential and commercial projects currently, and how is it expected going forward? Does this business lend itself to deeper relationships with reputed builders/contractors? Who are your top customers in FY11

Our sales are distributor driven and is difficult to give any breakups. Most of the revenues come from the residential segment and if were to put a figure it could be around 60-65%. This year we have started focusing on the replacement market too. Usually big builders have repeated us in subsequent projects.

11. COMPETITION STRATEGIES

Sooner or later bigger players with stronger brands (like Finolex, Supreme) will move into the CPVC market. It’s quite possible that these brands will have much stronger customer acceptance & pull than first-mover Astral. Kindly explain the company’s current thinking, brand building exercises undertaken and future plans.

As mentioned before, there are some 20 CPVC manufacturers in the country today. And all of them are playing a role in expanding the market as today everyone has good things to say about CPVC. In the earlier days the bigger PVC players were not so generous. We are happy about that.

Most of the non-Lubrizol licensee capacities are at a nascent stage and in 100s of tonnes. The largest may be some 3000 tonnes. The availability of the CPVC compound (other than Lubrizol) is a key constraint. Many are experimenting with in-house compounds. Also they have not been able to meet Lubrizol’s price point, and in a price-conscious market like India, that is often the bottomline!

12. CAPITAL EXPENDITURE. TO GROW SALES, ASTRAL NEEDS TO CONTINUALLY INVEST IN CAPACITY EXPANSION. WE HAVE HEARD CAPACITY EXPANSION PLANS TO 60000 MT FOR FY12.

What kind of capital expenditure will be required for this latest expansion. Some of the private players like Ashirvad Pipes Pvt Ltd. reportedly have expanded capacities to 70000 MT. How strong is the demand position? Is there a likelihood of overcapacity in the short to medium term?

Ashirvad Pipes is also a strong player. How much capacity is dedicated to CPVC I am unable to comment. There is enough demand for all of us to grow strongly in this market. We are looking to expand to 70,000 MT by this year end.

As you know we have acquired land at Dholka, Gujarat and a leased facility is available in Hosur, Karnantaka. We also have another 75000 sq mt of land in Dahej under our subsidiary Astral Biochem. Land is a key constraint in expansion plans, we have enough land acquired to meet our expansion needs for the next 4-5 years.

The Dholka plant will be a 25000 MT expansion which will come up in FY12. Hosur facility may be taken up subsequently as we need more capacity. The existing plant which has 45000 MT capacity can accommodate another 15000 MT or so.

Capex is done in a phased manner. We usually try to create capacity that we will need for the next year, a year ahead. You may have noticed most of the capex happens in the last one or two quarters of the financial year. Funding is not an issue today as we have strong cash flows and strong balance sheet, that we can leverage judiciously.

13. BACKWARD INTEGRATION.  IN OCT 2010, APL BOUGHT 85% STAKE IN ADVANCED ADHESIVES PVT. LTD. THE SUBSIDIARY COMPANY WILL MANUFACTURE SOLVENT CEMENT IN INDIA.

What are the plans on this front? Is this only for captive use or for generating additional sales as well? What kind of capex will be required going forward?
How much was the expense incurred in Solvent cements RM as a percentage of Sales? Is it mainly used for pipe fittings? What will be the contribution towards margin expansion, if any, on account of this?

Solvent cements accounted for roughly 6% of Sales as an expense item. This will be used for captive use and also supply to local players.

14. MARGINS – SUSTAINABILITY. THERE HAS BEEN A SLIDE IN MARGINS EVERY QUARTER FOR THE LAST 4 QUARTERS. OPERATING MARGINS (EXCL OTHER INCOME) HAS ACTUALLY SLID FROM OVER 16% TO JUST OVER 11% IN Q3FY11 – A SIGNIFICANT CONTRACTION OF OVER 5%! (RAW MATERIAL/SALES HAS REMAINED BETWEEN 64%-66.5% ROUGHLY)

Kindly explain the circumstances leading to this. Is this a short-term scenario and have we seen a good reversal in Q4 given that historically this is your best quarter? What levels do you see margins sustaining in the next 2-3 years?

PVC market is a highly crowded space and the OPM levels are not more than 8-10%. It’s a sort of a commodity business now. With more acceptance of CPVC and competition coming in, would it happen for CPVC market also…if not why? Where do you see margins sustaining over the next 2-3 years?

What you are comparing is sequentially quarter on quarter basis. A better comparison would be comparing annual figures where there has been a smaller decline. We should be within the historical 13-15% range on annual basis.

Whenever we introduce new products in the market, we go aggressively after market share. FY10 and FY11 has seen many new product introductions and therefore there is a dip in margins. We believe that at the rate we are growing, we have to take some margin pressure along our stride, as long as we stay within the historical range. Eventually economies of scale will deliver.

15. RAW MATERIALS – CPVC COMPOUND, PVC RESIN. RISK MANAGEMENT

With a rising crude prices scenario, raw material pries must be a cause for strain. Kindly explain how the company manages raw material price volatility risks. Does it get any advantage from sourcing majority of RM from Lubrizol? How often does it revise prices? Are you able to pass on price increases? How often have you resorted to price increases in FY11? When crude had crossed $150 in 2008, were you able to raise prices? What is the outlook for FY12?

How much is CPVC compound as a percentage of total RM? Do you see any risks in being tied to a single supplier (Lubrizol) for majority of RM requirements? Where do you source your PVC requirements from – RIL?

We used to get 180 days credit from Lubrizol earlier. Now it is 120 days. They do not revise prices often. Earlier it used to be once a year. With the current volatility it is more like once in 6 months. It is unlike the PVC supplier quotes which react instantly on spot rates and updates are sent on SMS! About 60% of RM is on account of CPVC.

16. FOREIGN CURRENCY – IMPORTS & FCNR LOANS. RISK MANAGEMENT.                       APL HAD INCURRED A LOSS OF RS.13.44 CR ON EXPOSURE TO FOREX DERIVATIVE CONTRACTS. IN FY10, THE FCNR LOAN STOOD AT 23.5 CR AND IMPORTS AT 104 CR.

What is the current FCNR loan position? Have all forex derivative contracts expired in full? After the FY09 experience, can you confirm that forex risk management practices adopted by the company are more conservative now?

There are no outstanding long-term contracts. FY09 was a difficult year. Forex volatility Management is part of regular business, we do not foresee extreme impact like that experienced in FY09.

17. SALES DISTRIBUTION NETWORK. DISTRIBUTION POLICY. 250 DISTRIBUTORS, 5500 DEALERS. TYPICAL OTHER EXPENSE SPENDS ARE 12-15% OF SALES.

How strong is the dealer/distribution network today? How important is the distribution network to sales growth for Astral? How does the company support this distribution network? Typically what kind of budgets do you allocate for Sales & Marketing spends?

We have 350 distributors and 7000 dealers today and we are constantly looking at strengthening this network. We believe this loyal distribution network is a core strength. The direct sales force works to nurture this network, as all sales incl. project sales are also routed through this network. We help dealers penetrate new markets by sharing promotional costs. We have recently taken on Mudra as the Ad agency for a promotional campaign with a 1cr budget. There is no fixed budget allocation for Sales & marketing spends, but is decided based on the targets set for the year.

18. DIVIDENDS. DIVIDEND POLICY. PAYOUTS

The company has started distributing dividends since 2008, Dividend payouts as a percentage of net profits has been rising, but still pretty low at ~8%. Kindly elaborate on the dividend policy followed by the company.

As you know we are growing at a strong pace, and we need all the cash that we generate and more. There is no enunciated dividend policy as such, and dividends are likely to remain at similar levels for next 2-3 years.

19. WARREN BUFFETS TAKEOVER OF LUBRIZOL.

 Any likely impact on the relationship? Please comment.

Our relationship goes back 11 years. We have seen four changes in ownership in these many years. From BF Goodricke, to Noveon, to Lubrizol and now Berkshire Hathway. Our relationship and support from Lubrizol has been very strong. We expect the same policies to continue for our markets.

20. CHALLENGES BEFORE THE COMPANY

Kindly elaborate on the main challenges faced by the company in view of the huge opportunities that lie ahead. How confident are you of reaching the turnover of Rs 1000 Cr an by when?

As mentioned before we should do Rs. 1000 Cr within the next 3 years. There are several big application markets that we need to tap effectively. Blazemaster is one, Solar applications is another. Along with the results, we will announce a few new initiatives!

Results on 20th May 2011. Analyst Meet on 25th May, 4-6 PM, Trident, Mumbai. Please be there!

 


Disclosure(s)

Nagabrahma: No Holdings in the Company; Recent Entry;
Janak Merchant: No Holdings in the Company; ;
Donald Francis: Less than 5% of Portfolio in the Company; Recent Entry;
: ; ;

Astral Poly Technik Management Q&A: Aug, 2012

Management Q&A

  1. TOTAL MARKET OPPORTUNITY

While there are no industry published figures, several estimates by analysts have pegged the annual market for Plumbing Pipes in India anywhere between 20000-30000 Crs. Of these 6000-7000 Cr is still GI use. Another 1000 Cr is for specialty solutions like Fire-Sprinklers, etc. About 30% is Replacement market.

  1. EXISTING PRODUCTS COMPETITIVE LANDSCAPE

In the CPVC Lubrizol segment as you are aware Ahshirwad, Astral and Ajay are the only Players. Ashirwad is a big well-established player. Ajay is yet to show any significant volumes.

In CPVC Generic segment there are several players. But they still are facing issues on the RM (compounding) stage. Kaneka is supposed to set up a manufacturing plant by 2014 end.

There is a 6-7% price differential with the generic players. But if you look at it, pipes constitute only about 1-1.5% of overall cost of the plumbing solution. We haven’t seen any impact, our volumes are not dropping. There is room for everyone to grow.

Doesn’t Kaneka supply the CPVC Compound too?

Well they do. But in India everyone wants to be able to do the “jugaad”; people try to make their own compounds; that can save them some 5-7%. But that has not been working out.

And the PVC Segment?

PVC is a huge market by itself. But there is high competition. We are not present in the Agri segment which sees cut-throat competition, with very low margins. Players like Finolex dominate this segment. Then there are players like Supreme who are present in both Agri & Plumbing.

With the Hosur Plant in South India, we will be able to compete more effectively, as transportation costs are high; adds up another 7-8%.

  1. BUSINESS GROWTH DRIVERS – PLUMBING SOLTION BASKET

Last time we understood …..End customer is really the Plumber, serviced by Large Distributors. The Plumber usually buys the entire solution basket -from one Brand. So large distributors can be attracted and retained – if you are able to offer a) complete solution basket, b) More number of solutions

We have about 300-350 distributors. All the states put together, no of dealers will be 9000-10000. Distributors keep 3-4% and the Retailer retains on an average 7-8% margins.

Project Sales are handled by Distributors with some 8-10% margins. Support is provided by the company for Project Sales..

We continuously try to interact & educate Focus groups. Consultants, Architects and Builders for Project Sales and Plumber Groups for Retail Sales. In the Southern Market we have seen Plumbers are more educated. The West market requires huge training. We conduct almost 3 trainings every week there.

Our product basket is widening and we are able to provide solutions for most requirements from the Astral brand umbrella. This helps our distributors and dealers as builders or retail customers usually like to source from one place.

CPVC

As you know we have 4 products licensed from Lubrizol. Flowguard, CORZAN, Blazemaster and Bendable. Ashirwad & Ajay have only the Flowguard license.

PVC

We have Aquarius (lead free PVC) brand. SWR. Column Pipes is what we have recently launched and expect to be able to do about 40-50 Cr from this segment. In 3 years we are looking to do 300 Crs from this segment. Ashirwad has a virtual monopoly and derives 300 Cr from this segment of the ~500 Cr Column Pipes annual market.

Ashirwad claims some patent for Column Pipes?

These are Marketing tactics everyone employs! In terms of technology/design barriers there is no impact or value derived from these. You might be aware some other CPVC player also claims patent-pending Alignment technology!

SOLVENT CEMENT

As you are aware this is handled through a 100% subsidiary. We have plans to supply for the Generic players needs; also open to White-Labelling.

We have launched this for PVC segment. This is slow-moving, we are doing 8-10 Cr from this segment. Margins are better than existing products. In Q3, we will also be launching Solvent Cement for CPVC segment. There should be some positive impact on the bottomline, as this will be an import substitute.

  1. NEW PRODUCTS

BENDABLE

This is a patented product from the Lubrizol stable. 3-4 years have gone in the R&D and commercialisation phase. So another 16 years of patented life exists. Astral is the only licensee of this product currently. Exclusivity for Indian market. We may be able to export some.

These products are good for Solar Applications. Because of thermal expansion properties of water, you may have seen the pipes become zig-zag and eventually break. So Bendable pipes come with a metal support, so the thermal expansion does not happen. Gas application is another market.

Limited market size. Currently metal pipes are used, only Copper, plastics are of no use. So Bendable offers a much cheaper solution. This will have better realisations, but initially market development efforts may require offering lower.

We have set up capacity of 11000 MT and are perhaps looking at 60-70 Cr turnover. Currently wen have tooling for 1/2”, 3/4” and 1”. We have ordered tooling for 1/4”, 1 1/2” and 2” that will complete the solution basket.

BLAZEMASTER

This is a CPVC solution for Fire Sprinkler system. Fire Sprinklers have the additional complexity of having continuous water, so there is heavy corrosion. So GI solutions are not very good here. Every 5-6 years you will have to paint/repair; there is replacement headache, besides all the transportation & handling. GI has been also banned in developed countries.

This is a very promising product line. Fire Sprinkler systems are becoming mandatory for commercial buildings, malls, hospitals. This is projected as a 700-1000 Cr annual market.

Astral is the exclusive licensee of Lubrizol in India.

  1. LUBRRIZOL RELATIONSHIP

Nothing to add really. The relationship is going strong. We are the only Licensee in the world to have 4 products form the Lubrizol stable. Bendable, their patent-protected technology – Astral is the first and only licensee globally.

  1. MEDIUM TERM OPERATIONAL OUTLOOK

We have always tried to communicate, ours is a Growth-led strategy. Consistent Margin expansion is NOT our focus. We are happy to achieve a 25-30% growth rate consistently and at 12-14% sustainable EBITDA margins.

FOREX MANAGEMENT

There are no easy solutions here. You must have seen everyone struggling to manage the extraordinary volatility. In Astral’s history, this is the first time we have seen 20-25% depreciation of the Rupee (versus the US $) in 6 months and a 10% appreciation back in 1 month.

We need to weigh the Forex Loan (2%) versus the domestic Interest cost (13%). So there is an 11% interest cost arbitrage available which needs to be weighed against the liability size of possible Forex loss.

We had taken a Forex currency loan of 15 Cr in 2003. We have been taking Forex currency loans. For the next 6-7 years this has worked hugely to our advantage, as the currency movement was only of the order of 5%. But this is obviously not working in the current environment of extreme movement.

Despite the 20% depreciation in currency and the M2M loss, the cost of Forex Loan over its full tenure will work out cheaper than our domestic rupee loans.

And the forex payable to Lubrizol for the 120 days credit terms? Why don’t you hedge this?

In a stable environment the 120 credit period from Lubrizol has been a great advantage to us – leading to negative working capital for the CPVC side of the business. If we were to hedge the payable, we would have to pay a 4-5-7% premium and this will take away the credit period benefit and impact our margins.

As a corporate we make long term strategies and work on it…when such extreme currency movements happens which are beyond anyones imagination, its obviously tough to handle. We need to understand what’s going on and revise strategies, and tweak them to see what works. Everybody faces the same choices – including the Generics. Strategy can’t be based on Abnormal conditions.

M2M ACCOUNTING

If you look at it properly, there is undue focus on the 1 to 1.5% drop in EBITDA margins. We can actually take a 60-90 day cover and there will be no change in EBITDA level, will you be happy with that?

From our perspective, it is also not correct to look at it from a Quarterly basis,either. In Q1 there was some M2M, in Q2 there was Zero M2M. And in Q4 everyone was hugely surprised to see the 18% EBITDA margin – no one had expected this. This was because of the price hikes we had taken, the lag effect and the effect of currency appreciation. In Q2 we had taken a 6-7% price hike, overall for the year 13% price hike.

We have tried to explain this to everyone. 18% EBITDA levels are not sustainable, 12-14% is. No need to be happy about the 18% EBITDA margin in Q4. No need to be PANICKY either. Better be prepared for reasonable margins of 12-14%.

Overall we don’t think all this is such a problem. Quarterly adjustments do not provide the right picture. So we have opted to adjust on a yearly basis at the year-end due to reasons mentioned above.

CAPACITY

We are at 65000 MTPA today in Gujarat. We are incurring 40-50 Cr Capex for putting up another 15000-20000 MTPA capacity at Hosur. This will be available by the year end.

  1. LONGER TERM OUTLOOK

Ours is a simple Pipes business. The Indian plumbing market is growing at 12-15% annually. We are capable of growing at 25-30% rate consistently, which we should be happy for. The growth drivers are Capex and Working Capital. One part of the business CPVC (60%) is Working Capital negative. And another part PVC (40%) has huge working capital requirements. For a couple of more years we will need to keep borrowing to finance this growth.

Do not jump to conclusions based on Q1 results. Our business is slightly seasonal. 1st half delivers 40% and the 2nd half 60%.

This is a very simple business. Any player can grow in this market. It’s a Capacity game. It’s a New Products game. It’s an Asset Turnover game. What goes to our advantage is Asset Turns of 5x. Supreme Industries is a live example in front of you.

In 2007, we were preparing for an addressable market (ours) of 1000 Cr. We are now preparing the plants for addressing a market of 2000Cr.

8. BRAND BUILDING. PROMOTIONS

We have been building up the Astral brand with our target customer base – Plumbers, Architects, Consultants, Builders/Project segment.

We will next attempt on educating the CONSUMER directly. There are some mass media events planned in October/November timeframes.

Astral products have typically been behind the Wall. There is no aesthetic appeal per se. We are trying to formulate plans for future products which will come in Front of the Wall. Since the customer segment and typical distribution network is the same, it may make sense for us!


Disclosure(s)

Vinod Ms: No Holdings in the Company; ;
Gaurav Sud: No Holdings in the Company; ;
Ayush Mittal: Less than 5% of Portfolio in the Company; Holding for more than 1 year;
Donald Francis: More than 5% of Portfolio in the Company; Holding for more than 2 years;

GRP

Background

Gujarat Reclaim and Rubber Products Ltd. (GRRPL) produces reclaim rubber from scrap of whole tyres, tread peelings, natural rubber tubes, butyl tubes, moulded rubber products for different applications in both tyre and non-tyre rubber products.

Established in the year 1974, Gujarat Reclaim started production with a modest capacity of only 2400 MT. After years of steady growth, it has increased its capacity by many folds (40,000 MT in FY10), and has widened its geographical presence in India and abroad (supplies across 45 countries). GRRPL operates from three locations in India’s north-west (Ankleshwar, Panoli) and south-west (Solapur).

Gujarat Reclaim has acquired a 3.6 MW windmill in the last quarter of FY10 in Gujarat. For the power units generated by windmill, the company gets credit in the electricity bill of its Panoli plant in Gujarat.


Main Products/Segments

Today Gujarat Reclaim has emerged as the largest manufacturer of reclaim rubber in the country and among the top 3, globally. Of total sales of Rs.140.67 Cr for FY10, domestic sales comprise Rs. 61 Cr (43.36%) and Exports comprise Rs.79.67 Cr (56.64%).


Main Markets/Customers

Major user industries are Automotive tyres & tubes, belts, automotive & industrial hoses, adhesives & sealants, civil construction applications.

Overall growth projected by the Rubber Board for the reclaim rubber industry for the next 4-5 years is at 8-10% year-on-year. If prices of virgin rubbers escalate at the current rates, this growth could easily be higher. Reclaim rubber is preferred for industrial use to the traditional virgin polymer because of its several advantages. Reclaim rubber is readily available in the country, is energy saving & the price of reclaim rubber today is around 25-30% of the polymer prices.

Exports contributed 57% of Sales in FY10.


Bullish Viewpoints

  • Good Industry prospects – Reclaim rubber is an eco friendly industry and with the rising prices of natural rubber, demand for reclaim rubber should increase going forward.
  • Consistent Margins and Profitability – Gujarat Reclaim has a neat track record of consistent growth and profitability. 5 Yr CAGR has been about 24% and 10 Yr CAGR has been at about 28%. Operating Profit Margins have generally been in the range of 16-19% and Net Profit Margins in the range of 9-11%.
  • Good Dividend record – Gujarat Reclaim is shareholder friendly and has a track record of continuously increasing dividends. 5yr DPS CAGR is 19% wheras 3yr DPS CAGR is almost 22%. Dividend payout ratio currently is about 19%.
  • High Returns – The business model is strong and the co generates high ROCEs. While it used to enjoy 40%+ returns, the last 2 years has seen returns 30%+ which is pretty good given the prevailing economic scenario.
  • Steady Growth – The company maintains that the new challenge before GRRPL is to maintain annual growth in excess of 30% and at the same time not waver from its path of building and consolidating trust among its growing number of stakeholders.
  • Recent Financial performance – For 9m FY11 Gujarat Reclaim has done Net Sales of 139 Cr (104 Cr 9m FY10) and PAT of 13.69 Cr (10.83 Cr 9m FY10). The company looks set to register a healthy 25-30% growth in FY11
  • Decent Valuations – at 915 CMP, the stock is available at ~7x FY11 EPS and 1.9x BV

Bearish Viewpoints

  • Capacity constraints – For the last 3 years installed capacity of reclaim rubber is stagnant at 41000 MT. In FY11, the company reportedly has expanded capacity at its Panoli plant by 6000 MT and a new plant is being commissioned at Solapur.
  • Expanded capacity utilisation – Increased capacity that is reportedly coming onstream by FY12 may lead to underutilisation and impact near-term profitability.
  • Raw material prices – Raw material/Sales has been steadily going up over the years. From roughly 40% in FY06 this is up over 45% in FY10. The rise has however been gradual and generally been offset by improvements in sales general & administration (SG&A) costs, power & fuel costs, etc. without really affecting operating margins.

Barriers to entry

  • In FY10 the installed capacity of reclaim rubber in India is estimated to be 150,000 tonnes, of which nearly 60% is manufactured by small scale industrial units, many of them maybe having obsolete machinery and processes.
  • Gujarat reclaim with an installed capacity of 41000 MT is the largest manufacturer and exporter of reclaim rubber in the country. Exports contributed 57% of Sales in FY10
  • GRRPL products are approved at 7 of the top 12 tyre companies in the world and 4 of the top 10 non-tyre rubber makers in India, the United States, Australia, France, Japan, Korea, Spain, and United Kingdom, among others.
  • One of the key strengths of GRRPL is that it has developed a wide network for raw material procurement and built an extensive chain of raw material suppliers. They are supported in procuring waste tyres from various state transport companies and other local collection sources. The suppliers act as agents of the company in reaching out across cities they operate in, to district and village level centres gathering the 45,000 tones of materials required at GRRPL factories.

Interesting Viewpoints

  • Gujarat Reclaim is focusing on sales of synthetic rubber reclaims which command higher value and realisation compared with the Natural rubber based reclaims. GRRPL has been a pioneer in the manufacture of reclaimed rubber from synthetic rubbers such as butyl, EPDM, nitride, etc. With increasing emphasis in the use of virgin synthetic rubbers for rubber compounds the world over, the future holds immense potential for the consumption of synthetic reclaim rubber, mainly in the non-tyre rubber goods manufacturing. The synthetic rubber reclaims business has grown significantly over the last few years and contributes approximately 45% of GRRPL’s total revenues.
  • Depending on the tyre type, reclaim rubber in a tyre can be as low as 0.5% to total polymer (in case of high performance PCRs) to as high as 12% to total polymer (in case of OTRs) and a further high of 35% (in case of cycle tyres). The Indian tyre industry as a whole consumes 4% reclaim rubber of total polymer. But individually, certain companies are also experimenting at levels of 6-7%.
  • The generation of scrap tyres and other waste tyres is a global phenomenon. Whichever country or region that has sufficient volumes of such scrap generation has an opportunity to have a reclaim industry. However, the consumption and market for reclaim rubber will depend upon where the production of reclaim rubber is. The global reclaim rubber industry has grown from being 2% of total polymer consumption in early part of last decade to close to 5% currently. China leads the way with the largest base for reclaim rubber manufacturing and also the highest consumption as proportion to virgin polymers.

Disclosure(s)

Donald Francis: No Holdings in the Company;